In the first place, forex option trading, like other speculation forms , has a goal that is more important than anything else ; make some money ! If this is the premise we start out with, that our goal is to make money , how is this achieved in our massive global market?
First you must decide whether you’re a fundamental or technical trader, or perhapse both . Later we’ll have more articles on this topic , but for now let’s assume that you like to follow world affairs and current events and are therefore attracted to the fundamental side of the game . Then you have to ask, what are the single most important fundamental factors that drive currency movements ?
If focusing on the fundamentals , one main thing is going to drive the decisions you make in forex trading; interest rate differentials between countries . You may wonder what an interest rate differential is? Great question ! Suppose there is a short term interest rate of 4% on the Australian Dollar . Meaning that if you are a debtor and you live in Australia this will be the base rate that determines what you pay on your home mortgage, your credit cards, etc . If you’re a creditor you can use this 4% short term interest rate as your base rate that decides how much your investments make; which can include certificates of deposites that come from a bank locally. Then suppose that the short term interest rate of the US Dollar, which is set by the Federal Reserve, at only 1% . So how in the world does what I just said affect currency movements ?
If the Australian Dollar short term rate is at 4% and the US Dollar short term rate is at 1% it’s all as simple as this : investors want their investments to have a higher yield and because they can get more interest in Australia funds are then moved by them to the land “Down Under” . The investment shift of capital leaving the United States and moving to Australia leads to a weakening of the US Dollar because supply is larger than demand and this strengthens the Australian Dollar because the demand suddenly becomes greater than supply . Economic fundamentals are working here ; where there is more demand for something its value will rise .
When you think about your own forex option trading and the next position to put on , ask yourself , ” which country will moving forward have higher rates and what country probably will have the lower rates moving forward?” Purchase currency that is the high interest rate favorite and sell the currency that you favor for weaker interest rates and increase profits as investors leave currency that is weaker and go towards the one that is stronger. This is the essence of forex option trading.
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